Currency crisis transmission through international trade

The Eurozone recent crisis has shown how balance of payments problems in less developed European Monetary Union (EMU) member countries can affect EMU trading partners, spreading the crisis to a larger group of countries. This paper introduces a three-country dynamic general equilibrium model to analyze whether and how terms of trade effects can generate a spillover effect or a currency crisis transmission between countries. Specifically, using a two period model, it incorporates world market clearing conditions for tradables into a new theoretic model, analyzes net capital flow movements between countries, and establishes cross-border macroeconomic linkages. This paper shows how a currency crisis can transmit through the real (trade) sector channel of the economy.     

Why risk popular ratification failure? A comparative analysis of the choice of the ratification instrument in the 25 Member States of the EU

Following the European integration history, referenda are a risky ratification strategy. Despite establishing a convention and intense treaty negotiations, an unprecedented number of eleven member states announced a referendum for the ratification of the constitutional treaty in 2004, two of them finally failed and stalled the ratification process. This study examines the choice of the ratification instrument by an empirical analysis of the strategic interaction between government, opposition parties and the electorate in the 25 ratification countries. Our analysis considers country-specific conditions and correctly predicts most of the ratification choices in countries which announced referenda (65%) and almost all parliamentary ratification cases (93%). The results reveal that governments choose referenda when they expect low gains from a treaty reform or are confronted with a Euro-sceptical parliamentary opposition. We also find that governments are eager to separate popular votes from domestic electoral campaigns.     

A simple inflation indicator for the euro zone

This article proposes and estimates an inflation indicator for the European Monetary Union (EMU). This indicator is set up so that it is contemporarily not affected by the changes in price differentials among EMU countries. The results show that the Monetary Union Index of Consumer Prices (MUICP), which is the inflation measure that the European Central Bank (ECB) takes as a reference for monetary policy purposes, could be understating the value of the inflation in the euro zone. It is also concluded that regional peculiarities are fundamental in the evolution of prices in the different EMU countries.     

Testing for the stability of money demand in Italy: has the Euro influenced the monetary transmission mechanism?

Stability of money demand is a crucial issue for the efficacy of monetary policy. This is particularly true in the presence of significant exogenous shocks to the monetary system. By implementing the most recent econometric testing procedures, this article intends to investigate the consistency of the stability of money demand in Italy, one of the larger European Monetary Union (EMU) countries, before and after the EMU. Among others, the objective is, indeed, to ascertain the effect of a change in the currency regime on the monetary aggregates and to provide a valid empirical model which is a viable tool for policy performance.     

Leader of the pack? German monetary dominance in Europe prior to EMU

In this paper, the monetary policy independence of European nations in the years before European Economic and Monetary Union (EMU) is investigated using cointegration techniques. Daily data is used to assess pairwise relationships between individual EMU nations and ‘lead’ nation Germany, to assess the hypothesis that Germany was the dominant European nation prior to EMU. By and large our econometric investigations support this hypothesis, and lead us to conclude that the only European nation to lose monetary policy independence in the light of monetary union was Germany. Our results have important policy implications. Given that the loss of monetary policy independence is generally viewed as the main cost of monetary unification, our findings suggest a reconsideration of the costs and benefits of monetary integration. A country can only lose what it has, and in Europe the countries that joined EMU — spare Germany — apparently did not have much to lose, at least not in terms of monetary independence. Instead, they actually gained monetary policy influence by getting a seat in the ECB's governing council which is responsible for setting interest policy in the euro area.     

The Impact of 2007/08 Financial Crisis on the Stability and Enlargement of the EMU

Before 2007/08, the European Monetary Union (EMU) was expected to be enlarged on schedule, but the European sovereign debt problem, triggered by the exogenous US sub‐prime crisis, not only has revealed the EMU's fiscal coordination failure, but also has weakened regional financial integration. The stagnation of financial integration will therefore increase the cost of sustaining a monetary union, which in turn slows EMU enlargement and ruins the reputation of the euro. This paper aims to measure the damage to financial integration and to provide a more precise answer on real interest rate parity (RIP) convergence. Our estimation indicates that RIP between the EMU and some accession candidates is still valid after the interruptions of the financial crises. However, convergence of real interest rates cannot be achieved until 2030. This implies the EMU authority must strengthen regional financial integration to solidify the EMU and then be able to re‐start enlargement.     

Time-varying effects of fiscal policy in Spain: a Markov-switching approach

How have the effects of Spanish fiscal policy varied over time? Given this starting point, in this article we analyse the regime dependence of fiscal policy in Spain by estimating a vector autoregressive model within a Markov-switching framework. Our results indicate that Spain’s membership of the Economic and Monetary Union (EMU) is the most likely source of time variation in the fiscal outcomes. Accordingly, increases in the primary deficit-to-GDP ratio do not succeed in stimulating economic activity in the first regime; rather, unexpected upsurges in the primary deficit harm economic activity (non-Keynesian effect) in the second regime, which prevails since the ratification of the Maastricht Treaty.     

Perspectives for Future Economic Policy Coordination within EMU

While rules, procedures and institutions for economic policy-making in EMU have been put in place, their functioning is still open to the tests of reality. The singular mix of a centralized monetary policy and decentralized fiscal (and structural) policies makes coordination procedures a necessity, if an optimal policy mix pursuing the objectives of Art. 2 TEU is to be achieved. Inclusion of social partners into macro-policy coordination, as proposed in the new European Employment Pact, is a necessary complement, if wage policy is to play its role as a shock absorber for asymmetric shocks, but also in order to align policy orientations of all actors. While during the start-up phase of EMU each policy actor focuses on his own independence and autonomy, in the future the everyday task of conducting economic policy will lead to a more pragmatic cooperation by all actors.     

Does the Single Currency Affect Foreign Direct Investment?*

Does the creation of the euro partly explain the sharp increase in European investments? To address this question, we derive a simple gravity‐like model for bilateral foreign direct investment (FDI). Using this model, we find that the Economic and Monetary Union (EMU) has increased intra‐EMU FDI stocks on average by around 30 percent. This effect varies over time and across EMU members. It is found to be larger for the outward investments of the less‐developed EMU members. Moreover, contrary to early expectations of FDI diversion effects, EMU countries have invested more in non‐EMU countries since the launch of the euro.     

THE TRANSITION TO EUROPEAN MONETARY UNION AND THE EUROPEAN MONETARY INSTITUTE

The European Monetary Institute (EMI) will prepare a framework for European Monetary Union (EMU) monetary policy during the transition to the EMU. This involves a trade-off between deepening financial market integration and harmonizing central bank instruments, a choice between centralized and decentralized monetary strategies with significant welfare implications, and a trade-off between expected welfare and certainty of policy outcomes. As a result of being dominated by national central bankers and of the conflict between the core and the periphery of the European Community (EC), the EMI is biased toward an inefficient solution. Enlargement of the EC by the European Free Trade Area (EFTA) group would raise the probability of a more efficient, two-track EMU, which initially would involve only the core group.     

Bond market and stock market integration in Europe: a smooth transition approach

This article investigates whether there has been a structural increase in financial market integration in nine European countries and the US in the period 1980 to 2003. We employ a GARCH model with a smoothly time-varying correlation to estimate the date of change and the speed of the transition between the low and high correlation regimes. Our test produces strong evidence of greater comovement across the board for both stock markets and government bond markets. Dates of change and speeds of adjustment vary widely across country linkages. Stock market integration is a more gradual process than bond market integration. The impact of European monetary union (EMU) is rather limited, as it has mainly affected the timing of bond market correlation gains (but hardly their size) and has had little discernible effect on stock market integration.     

Inflation and inflation uncertainty in the euro area

This article estimates a time-varying AR-GARCH model of inflation producing measures of inflation uncertainty for the euro area, and investigates their linkages in a VAR framework, also allowing for the possible impact of the policy regime change associated with the start of EMU in 1999. The main findings are as follows. Steady-state inflation and inflation uncertainty have declined steadily since the inception of EMU, whilst short-run uncertainty has stabilised. A sequential dummy procedure provides further evidence of a structural break coinciding with the introduction of the euro and resulting in lower long-run uncertainty. It also appears that the direction of causality has been reversed, and that in the euro period the Friedman-Ball link is empirically supported, consistently with the idea that the ECB can achieve lower inflation uncertainty by lowering the inflation rate.     

Has Inflation Persistence Changed under EMU?

This paper analyzes the persistence of inflation in the euro area and, in particular, whether the persistence properties have changed since the start of European Monetary Union(EMU). For that purpose, we compare pre‐ and post‐EMU inflation persistence, use rolling‐window estimates of persistence, and apply tests specifically designed to detect break dates near the end of the sample period. In contrast to previous research, we find that inflation persistence has fallen significantly since the start of EMU. Persistence of consumer price inflation, which is central to the European Central Bank's policy mandate, has fallen more than the persistence of deflator inflation. The drop in inflation persistence is consistent with the results from a simulated small New Keynesian model with a shift toward a more aggressive monetary policy stance.     

Has the Euro changed the business cycle?

In contrast to the notion that the exchange-rate regime is non-neutral, there is little evidence that EMU has systematically changed the European business cycle. In fact, we find the volatility of macroeconomic variables largely unchanged before and after the introduction of the Euro. Exceptions are a strong decline in real exchange rate volatility and a considerable increase in cross-country correlations. To account for this finding, we develop a two-country business cycle model which is able to replicate key features of European data. In particular, the model correctly predicts a limited effect of EMU on standard business cycles statistics. However, further analysis reveals that the Euro has changed the nature of the cycle through its impact on the transmission mechanism. Cross-country spillovers have become relatively more, domestic shocks relatively less important in accounting for economic fluctuations under EMU. This explains why there is little change in unconditional volatilities.     

THE POLITICAL ECONOMY OF EUROPEAN MONETARY UNIFICATION: AN ANALYTICAL INTRODUCTION

European monetary unification (EMU) - the creation of a single European currency and a European Central Bank - is both an economic and a political phenomenon. Yet few studies have attempted to address simultaneously the political and economic dimensions of the process. In this introduction, we review and extend the relevant literatures. The evidence leads us to conclude that EMU is driven mainly by political rather than economic factors, although our understanding of even these political forces remains incomplete.     

Macroeconomic variables and the sovereign risk premia in EMU,non-EMU EU,and developed countries

This project studies and models key macroeconomic variables and their impact on sovereign risk premia across select European economies and developed countries. The sample is divided into three groups of countries: those in the European Monetary Union (EMU); the standalone economies outside the EMU but members of the broader European Union (EU); and other developed economies. The main subject of examination across all three groups is the impact of macroeconomic variables on sovereign borrowing costs. EU countries have experienced high financial stress and a rapid rise in the credit default swaps (CDS) spreads during the EMU debt crisis. A nonlinear vector smooth transition autoregressive model is applied to investigate such a regime change in the finance-output link using sovereign CDS and industrial production index. The paper finds that regime-switching takes place rather suddenly in most EMU countries. The study concludes that due to the potential spillover effects in the EU as a whole, the individual country macroeconomic indicators were less reflected in the financial stress and spillover and contagion effects became dominant.     

Estimating the effect of the EMU on current account balances: A synthetic control approach

The European sovereign debt crisis wrought major political and economic damage on the European Monetary Union (EMU). This led to a reassessment of the pre-crisis period of economic growth and stability in the EMU, shifting attention to the macroeconomic imbalances that emerged between member states, especially those in current account balances. This paper uses macroeconomic data on OECD economies and a new statistical approach for causal inference in observational studies—the synthetic control method—to estimate the effect of the EMU on the current account balances of individual member states. This ‘counterfactuals’ approach provides strong evidence that the introduction of the EMU was responsible for the divergence in current account balances among member states in the run-up to the euro crisis. The results suggest that the EMU effect operated through multiple channels and that fundamental changes to the institutional framework of the EMU may be required to safeguard the currency union against a reemergence of dangerous external imbalances in the future.     

Business cycle affiliations in the context of European integration

We study affiliations for the countries of the European Economic and Monetary Union (EMU) with Germany and the USA, using various business cycle measures derived from quarterly real GDP. These measures are Hodrick-Prescott and Baxter-King filtered series and annual growth rates. By using rolling contemporaneous and maximum (over a short lead/lag interval) correlations, we document increasing correlations of EMU countries with Germany, with these typically being largest during the 1990s. We also document a strong leading role for the USA in relation to these countries in the period since 1993, thereby correcting the fallacy that the European business cycle was disjointed from the USA for most of the 1990s.     

EMU and the Lucas Critique

This paper attempts to provide a systematic review of the implications of EMU for the Lucas Critique. It asks how well cointegrating vector autoregressions estimated on pre-Euro data forecast post-Euro data, relative to their pre-Euro standard error. This is done for the Euro area as a whole, 3 countries that joined and 3 European countries that did not join. If the Lucas Critique is important, the forecasts should be much worse, because the policy change, EMU which changed exchange rate and interest rate determination processes, should have changed the parameters of the estimated models. The models appear to forecast very well and EMU does not appear to have induced structural change, indicating that the Lucas Critique does not seem to be important in this case.     

In or out? The welfare costs of EMU membership

Sweden and the UK have repeatedly refused to join the European and Monetary Union (EMU). Surprisingly, there is very little work on the welfare consequences of the loss of monetary policy flexibility for these countries. This paper fills this void by providing a framework to evaluate quantitatively the economic costs of joining the EMU. Using a two-country dynamic general equilibrium model with sticky prices we investigate the economic implications of the loss of monetary policy flexibility associated with the EMU for each country. The main contribution of our general equilibrium approach is that we can evaluate the effects of monetary policy in terms of welfare. Our findings suggest that these economies may experience sizable welfare losses as a result of joining the EMU. Results show that the cost associated with the loss of the monetary policy flexibility is higher in the presence of persistent government consumption shocks and small trade shares with the EMU.